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Inquiry into Audit Office legislation

Report of the Finance and Expenditure Committee

Forty-Fifth Parliament (David Carter, Chairperson) 1998

Contents

Summary of recommendations

Following its inquiry, the Finance and Expenditure Committee makes the following recommendations to the Government in relation to any new legislation governing the Audit Office:

  • That the Audit Office's mandate be extended so that it is able to conduct special audits of all the entities subject to its audit. With respect to State owned enterprises (SOEs), however, the Audit Office's mandate to conduct special audits should be limited to:
  • issues of waste, probity and financial prudence
  • compliance with statutory obligations, ministerial directions, and matters covered by statements of corporate intent or other documents tabled for the SOE in Parliament.
  • That provision be made appointing the Controller and Auditor-General to be the auditor of all organisations that comprise the Crown reporting entity pursuant to section 27 of the Public Finance Act 1989, with the exception of Officers of Parliament.
  • That provision be made to ensure that the Controller and Auditor- General is the auditor of all subsidiary companies and other related entities of those entities of which Parliament otherwise appoints the auditor.
  • That the Controller and Auditor-General be made the auditor of all other public sector entities of which Parliament appoints the auditor.
  • That the Controller and Auditor-General be recognised in statute as an Officer of Parliament and that the Audit Department be abolished as a Department of State.
  • That the method of appointment for the Controller and Auditor-General be amended so that it is by the Governor-General on the recommendation of the House of Representatives.
  • That the term of office for the Controller and Auditor-General be for a fixed period of seven years.
  • That the Controller and Auditor-General's accountability arrangements require him or her to:
    • present to Parliament an annual plan including forecast financial statements, the anticipated work programme, and performance targets for the office
    • table an annual report including an account of the performance or exercise of the functions, duties and powers attaching to the office, and an account of the stewardship of the public resources employed in the process.
  • That the Controller and Auditor-General detail the Audit Office's organisational arrangements in its annual plan including:
    • the structure of the Audit Office
    • the procedures being undertaken to promote the provision of contestable audit services.
  • That the Government address the need for legislation governing the Audit Office as a matter of priority.

Introduction

The need for an effective and independent Auditor-General is almost universally accepted. The Auditor-General plays an essential role in supporting Parliament in the function of authorising and supervising the spending of public money by the Executive. It is vital, therefore, that the legislative framework that governs the Office of the Controller and Auditor-General does not hinder it in providing assurances as to the integrity of the Crown's spending.

Currently, the structure and role of the Audit Office are derived largely from section 25 of the Public Finance Act 1977. Given the extensive reforms to the State sector since 1977, we believe that this legislative framework does not adequately provide for the functions, duties and powers of the Auditor-General in the public sector today. A review of the legislation governing the Audit Office is, therefore, long overdue. As far back as 1989, the Finance and Expenditure Committee drew the Government's attention to the need for legislation governing the Audit Office. Our inquiry carefully considered the policy issues involved in establishing a new legislative framework for the Audit Office and has produced a set of recommendations which we hope the Government will act upon as a matter of priority.

Our inquiry focused on the following four issues:

  • The appropriate extent of the Audit Office's mandate.
  • The span of entities to be covered by the Audit Office's mandate.
  • The appropriate accountability arrangements for the Audit Office and how to guarantee the office's independence.
  • The appropriate organisational arrangements for the Audit Office.

We called for public submissions and invited submissions from a range of interested parties. The Appendix to this report sets out the terms of reference for the inquiry, our approach, membership and lists of the evidence and advice received.

Scope of Audit Office Mandate

Current functions of Audit Office

The Audit Office's current functions, under section 25 of the Public Finance Act 1977, include ascertaining whether an entity's:

  • books and accounts have been faithfully kept
  • procedures, including internal controls, are sufficient to ensure that there is effective control over its revenue, expenditure and other resources
  • resources have been applied effectively and efficiently in a manner consistent with applicable policy.

The principal duty of the Audit Office is to report on both the results of individual audits and on matters arising from audits generally. Individual audits include audits of financial statements and audits of service performance information, where appropriate. The Audit Office undertakes other more discretionary activities, such as special audits. These audits investigate matters of concern identified by select committees, members of the public or by the Audit Office itself.

They may cover:

  • evaluations of management policies, procedures and controls in order to assess the efficiency and effectiveness of output production, and compliance with relevant laws and regulations
  • investigations of cases of suspected waste
  • audits of the effectiveness of the use of resources by governmental organisations in fulfilling the Government's objectives.

Issues for new legislation

As a general principle, the functions and duties of the Auditor-General should be determined by having regard to Parliament's function as the means by which the Executive is held accountable for the use of public resources. In summary, Parliament holds the Executive to account for the resources it uses through:

  • the scrutiny of, and agreement to, legislation proposed by the Executive, in particular appropriation bills
  • the scrutiny of organisational performance through Estimates and financial review examinations
  • the scrutiny of particular policies or aspects of administration through, for example, select committee inquiries.

We believe that the functions of the Audit Office ought to be focused around the nature of the matters that Parliament expects the Auditor-General to audit. The principal responsibility for providing information to Parliament about governmental performance should always rest with the Executive and its agencies. Indeed, the current environment is one in which the Government and its various sub-entities produce extensive financial and service performance information. Accordingly, the Audit Office's primary focus should be on providing assurances as to whether the financial and service performance of public sector organisations is fairly reflected in their periodic accountability statements presented to Parliament.

Parliament may also expect assurances about some aspects of governmental performance that cannot easily be discerned from the accountability statements. For example, particular aspects of a government programme or Organisation may warrant more in-depth examination. For this reason, Parliament has over a long period agreed to the Auditor-General having the resources to carry out special studies, provide advice to select committees, and respond to particular enquiries.

Concern has been expressed that the power to examine efficiency and effectiveness could involve the Audit Office in policy issues, and thus undermine its impartiality. Clearly, however, this issue will not arise if the special audit function only extends to an examination of whether the Government's policy has been implemented by the relevant agency in an effective and efficient manner. This intent should be made clear in any new legislation.

Under its existing mandate, the Audit Office may not undertake special audits of Crown entities, such as, Crown research institutes and Crown health enterprises. We believe that this state of affairs is contrary to Parliament's expectations, needs and interests. Parliament has a clear and identifiable interest in the activities of Crown entities, frequently from both an ownership and purchase perspective. Furthermore, we understand that the restrictions faced by the Audit Office in this respect are more a result of legislative oversight than deliberate intention. They arise from reference to particular institutional forms that existed when the 1977 legislation was enacted. No amendment has ever been made to the relevant provision of the Act to take account of the creation of new institutional forms within the State sector, such as Crown entities.

The situation with respect to SOEs differs from that of other State sector organisations. As a general principle, we believe that the Audit Office should be able to audit the full range of Parliament's interests, including its interests in SOES. However, this does not necessarily imply that the Audit Office should be given the authority to conduct a full range of special audits on SOES. Parliament does not have the same range of interests in SOEs as it does in other entities. Most significantly, Parliament has no purchase interest in SOES. In other words, Parliament does not directly purchase or otherwise fund SOEs to provide goods and services either to it or other parties. Neither does Parliament have direct control, over the actions or management of SOES. Parliament's interest in SOEs is restricted to that of shareholder. Because Parliament has no direct purchase interest in SOES, we believe it would be inappropriate for the Audit Office to be authorised to conduct efficiency and effectiveness reviews of service provision, since this concerns purely contractual matters to which Parliament is not a party.

We recommend that the Audit Office's mandate be extended so that it is able to conduct special audits of all the entities subject to its audit. With respect to SOES, however, the Audit Office's mandate to conduct special audits should be limited to:

  • issues of waste, probity and financial prudence
  • compliance with statutory obligations, ministerial directions, and matters covered by statements of corporate intent or other documents tabled for the SOE in Parliament.

Portfolio of Audit Office

Span of organisations for which Parliament should appoint auditor

As a matter of principle, we believe that Parliament should appoint the auditor of an Organisation when it is to Parliament to which that Organisation is ultimately accountable. Accountability is generally reflected in a requirement for the organisation's statements of account to be tabled in Parliament, and, in turn, for its performance to be subject to scrutiny by a select committee.

Given the constitutional origins of its role, Parliament's primary scrutiny interest is in respect of the Crown and its subsidiary entities. The Public Finance Act 1989 defines those entities that are in the Crown's estate as being:

  • departments
  • Offices of Parliament
  • SOEs
  • Specified Crown entities.

Our view is that Parliament should appoint the auditor of all entities comprising the Crown's estate. This is currently the case, with the exception of the Reserve Bank of New Zealand, where the auditor is appointed by the Minister of Finance. However, given that the Reserve Bank is clearly part of the Crown's estate, and is subject to select committee scrutiny, Parliament should assert its right to appoint the Bank's auditor.

Some public sector entities for which Parliament currently appoints the auditor are by other legislative arrangements not primarily accountable and subject to scrutiny by Parliament. As a general rule, Parliament should appoint the auditor of non-Crown public sector organisations where:

  • No practicable alternative exists for the community and other stakeholders of these entities to appoint an independent auditor; or
  • The entities exercise some form of coercive or other significant power
  • Conferred by Parliament.

Thus, Parliament currently appoints, and should continue to appoint, the auditor of local government organisations such as territorial and local authorities (including their subsidiary activities such as airports, local authority trading enterprises and port companies).

Many public sector entities conduct large parts of their business through subsidiary companies or through other related entities such as unincorporated joint ventures or trusts. These entities may be either created or acquired by the parent public sector entity simply by executive action, and result in the divestment and conduct of activities that might otherwise have been carried out by the parent entity itself. Most legislation in which Parliament appoints the auditor of the parent entity states that the same auditor shall also be the auditor of any subsidiary company. However, the inclusion of such a provision is determined on a case-by-case basis and usually does not provide for the audit of other related entities. It is thereby possible for public sector entities to avoid, by executive action, the level of external scrutiny that would otherwise apply. Clearly any legislative framework for the Audit Office needs to rectify this situation in order to protect the integrity of the accountability framework.

In his submission, Hon David Caygill suggests that community trusts holding shares in energy companies are remote from public ownership and parliamentary responsibility. These community trusts are constituted under general trustee law and are not accountable to Parliament. We agree that it is not Parliament's business to set the accountability arrangements for these trusts, as they are no different from any other trust in which a geographical community has an interes.

Appointing Auditor-General as Auditor

It does not necessarily follow that because Parliament appoints the auditor of an Organisation, it should automatically appoint the Auditor-General to that role. It is the practice, however, that when Parliament appoints the auditor of an entity, it mostly does this by appointing the Auditor-General. There are three substantive reasons for this:

  • The Office of the Controller and Auditor-General has statutory independence.
  • Benefits accrue from having a specialist professional agency principally devoted to serving Parliament's interests.
  • Parliament obtains the administrative convenience and economy of having to appoint and deal with only one auditing agent.

We accept that, as a general rule, the Audit Office should be appointed as auditor of the organisations for which Parliament has asserted its right to appoint the auditor. Currently, the only exception to this arrangement is in relation to the audit of Offices of Parliament where, pursuant to section 40 of the Public Finance Act 1989, the auditor appointed by the House of Representatives need not be the Audit Office. This arrangement is premised on a concern that it may create unnecessary conflicts if the Auditor-General were the auditor of Offices of Parliament. Accordingly, we believe that Parliament should reserve the right to appoint an auditor other than the Audit Office in the case of Offices of Parliament.

Current legislative arrangements provide for the appointment of the Audit Office as auditor by way of a general provision to be the auditor of public money and stores specific provision in various Acts.

This approach has resulted in differing audit arrangements across the public sector. Any new legislative framework should rectify this, and provide a consistent and coherent set of audit arrangements.

We recommend that provision be made appointing the Controller and Auditor-General to be the auditor of all organisations that comprise the Crown reporting entity pursuant to section 27 of the Public Finance Act 1989, with the exception of Offices of Parliament. We also recommend that provision be made to ensure that the Controller and Auditor-General is the auditor of all subsidiary companies and other related entities of those entities of which Parliament otherwise appoints the auditor. We further recommend that the Controller and Auditor-General be made the auditor of all other public sector entities of which Parliament appoints the auditor.

In its submission to us, the Reserve Bank of New Zealand expressed concern that the Audit Office lacks the necessary expertise to audit the Bank's operations satisfactorily. However, if Parliament were to appoint the Audit Office as the Bank's auditor, and in doing so require that the function be carried out in an efficient and effective manner, then the Audit Office would be obliged to use auditors who were competent to do the audit of the Bank.

To ensure that the portfolio of entities to be audited by the Audit Office is clearly prescribed, the portfolio should be specified in a schedule to any new legislation, by class where such classes exist, or by individual entity where no class exists.

Ensuring an accountable and independent Auditor-General

Independence of Auditor-General

Independence of the Auditor-General is a fundamental precept of the Westminister system. It is critical to Parliament's oversight of the operations of the Executive and public sector entities generally. We agree fully with the following statement made in the 1989 report of the Finance and Expenditure Committee on its inquiry into Officers of Parliament:

In the committee's view it is indisputable that the Controller and Auditor- General, as an independent 'watchdog', be placed on an independent statutory basis.

In this context, independence means being free to discharge the functions and duties of the office without improper influence from either the Executive or individual members of Parliament and select committees.

The independence of the Auditor-General needs to be considered in relation to both professional matters, such as the manner and terms of appointment as the auditor of public sector entities, and institutional arrangements, such as the method of appointment to and removal from office. We believe that independence in both of these respects is best guaranteed by statutory provision. The requirements for professional independence will be secured by Parliament appointing the Auditor-General as auditor and granting appropriate powers with which to discharge the functions and duties of the office.

Any new legislative framework for the Audit Office will need to address a number of issues to ensure the institutional independence of the office. Of primary importance is the constitutional status of the Auditor-General, the method of appointment of the Auditor-General and his or her term of office.

Constitutional status of Auditor-General

In its 1989 report on the inquiry into Officers of Parliament, the Finance and Expenditure Committee recommended that the Auditor-General be recognised in statute as an Officer of Parliament and that the Audit Department be abolished as a Department of State. Most of the submissions we received support the Auditor-General being placed on the same constitutional basis as other Officers of Parliament.

The status as an Officer of Parliament will clearly reinforce the fact that the Auditor-General performs a role that Parliament itself might otherwise carry out, and that the office is independent of the Government. The abolition of the Audit Department will sever the remaining statutory administrative connection with any particular Minister and with the public service. Clearly this will reinforce the Audit Office's independence from the Executive. We recommend, therefore, that the Controller and Auditor-General be recognised in statute as an Officer of Parliament and that the Audit Department be abolished as a Department of State.

Method of appointment

Currently, the Auditor-General is appointed by the Governor-General on the recommendation of the Prime Minister. As a consequence of formally recognising the Auditor-General as an Officer of Parliament, we recommend that the method of appointment for the Controller and Auditor-General be amended so that it is by the Governor-General on the recommendation of the House of Representatives.

Term Of office

Security of tenure is a principal measure necessary to ensure the independence of the Auditor-General. We note that the nature of the Controller and Auditor-General's function of investigating financial matters demands a security of tenure which other functions performed by Officers of Parliament may not. We recommend, therefore, that the term of office for the Controller and Auditor-General be for a fixed period of seven years.

Accountability arrangements

It is important that the Auditor-General be accountable for the performance or exercise of the functions, duties and powers attached to the office, and for the public resources applied in the process. At the same time, it is important that any accountability arrangements do not compromise the independence of the office.

Accountability arrangements for public sector organisations typically require:

  • ex ante specification and agreement of expected performance
  • ex post reporting and review of actual performance.

In considering the accountability arrangements for the Audit Office, it is important to note that if either one of these requirements is absent or weak, the prospects of holding the office to account are significantly reduced. If, for example, there is no clear ex antespecification of performance it will be extremely difficult ex post to form a view on whether the Auditor-General has performed adequately, as there is no benchmark for assessment.

Consistent with the proposed status of the Auditor-General as an independent Officer of Parliament, we recommend that the accountability arrangements require the Controller and Auditor- General to:

  • present to Parliament an annual plan including forecast financial statements, the anticipated work programme, and performance targets for the office
  • table an annual report including an account of the performance or exercise of the functions, duties and powers attaching to the office, and an account of the stewardship of the public resources employed in the process.

The proposed annual plan, which would outline the Audit Office's proposed discretionary audit programme, should be subject to scrutiny by the Finance and Expenditure Committee. The Audit Office should be required to consult with the Finance and Expenditure Committee on its strategic priorities and broad work programme prior to the start of each financial year. The Officers of Parliament Committee should also have a role in this process. Any disagreement over the office's plans should result in changes being made, provided this is done in an appropriate and transparent manner. The Finance and Expenditure Committee should then have a major role in monitoring the performance of the Audit Office against the targets and priorities outlined in the annual plan.

Organisational arrangements

At present, Audit New Zealand and the Office of the Controller and Auditor-General operate as two separate business units. Both units are formally under the control of the Auditor-General. However, the Auditor- General has put in place arrangements intended to enable Audit New Zealand to operate as an independent operating arm of the Auditor-General. The executive director has extensive delegated authority from the Auditor-General to operate autonomously, but is expected to consult over strategically significant decisions.

The separation of the purchaser of audit services from the provider aims to facilitate competition between Audit New Zealand and private sector audit service providers, to ensure that only the most effective audit service providers are contracted to act on the Auditor-General's behalf.

Contestability of audit service provision can be seen as a means of helping to ensure that competent audit services are obtained at a cost which represents value for money.

While we acknowledge the desirability of contestability, we accept that the Audit Office should maintain an audit capability. To remove the office's audit capability, by constituting Audit New Zealand as an SOE for example, would result in unnecessary risks to both the Crown and the Audit Office. Furthermore, such a move could impact negatively on the office's independence. In addition, the efficiency benefits of removing the Audit Office's audit capability have not been established.

While we approve of the current organisational arrangements, we do not believe that the purchaser/provider split should be formalised in legislation. To do so would impact on the manner in which the Audit Office's inputs are organised and rationed. Furthermore, the 1989 recommendation of the Legislation Advisory Committee was that legislation should not in general be enacted for administrative matters. However, we recommend that the Controller and Auditor-General detail the Audit Office's organisational arrangements in its annual plan including

  • the structure of the Audit Office
  • the procedures being undertaken to promote the provision of contestable audit services.

Conclusion

A new legislative framework governing the Audit Office is long overdue. An independent and yet accountable Audit Office operating under a well defined and appropriate set of statutory functions and duties will greatly enhance the accountability of the Executive and public -sector entities to Parliament.

We recommend that the Government address the need for legislation governing the Audit Office as a matter of priority.

Appendix

Committee procedure

Terms of reference

The Finance and Expenditure Committee resolved to conduct an inquiry into Audit Office legislation on 30 July 1997, with the following terms of reference:

  • (a) To review the functions, duties and powers of the Controller and Auditor-General.
  • (b) To review the range of entities to which the Controller and Auditor-General's functions, duties and powers apply.
  • (c) To consider the arrangements for the independence and accountability of the Controller and Auditor-General.
  • (d) To report to the House on these matters and make recommendations on the future legislative framework to apply to the Controller and Auditor-General.

Approach to inquiry

We met on 30 July 1997, 15 and 22 October 1997, 26 November 1997, 10 December 1997, 4 and 18 February 1998 and I April 1998 to consider the inquiry. The hearing of evidence took one hour and 20 minutes and we spent a further four and a half hours in consideration. We received 12 submissions on the inquiry from the organisations and individuals listed below and we heard three of the submissions orally. Advice was received from the Audit Office, the Ministry of Justice and the Treasury.

Committee members

  • Tony Ryall (Chairperson, 30 July 1997 to 10 December 1997)
  • David Carter (Chairperson, 4 February 1998 onwards)
  • Hon Peter Dunne (Deputy Chairperson)
  • Mrs Jenny Bloxham
  • Hon Dr Michael Cullen
  • Hon Brian Donnelly
  • Ruth Dyson
  • Marie Hasler
  • Rodney Hide
  • Mark Peck
  • Clem Simich
  • Belinda Vernon
  • R Doug Woolerton
  • John Wright

Advisers to committee

  • Martin Matthews, Assistant Auditor-General, Parliamentary Group, Audit Office
  • Phillippa Smith, Assistant Auditor-General, Legal, Audit Office
  • Michael Hyndman, Manager, Public Sector Management, Asset and Liability Management Branch, the Treasury
  • Ken Warren, Financial Management Director, Budget Management Branch, the Treasury
  • Paula Turley, Analyst, Asset and Liability Management Branch, the Treasury
  • Alex Frame, Public Law Office, Ministry of Justice
  • Elizabeth Thomas, Public Law Office, Ministry of Justice

Bibliography

We considered the following advice and evidence during our inquiry:

  • Audit Office discussion document, dated 19 July 1996, entitled Views of the Controller and Auditor-General on the Policy Issues for an Auditor-General's Bill
  • Advice from the Audit Office, dated 21 October 1997, 24 November 1997 and 2 February 1998
  • Advice from the Treasury, dated 28 November 1997 and 17 February 1998

List of submissions

  • Hon David Caygill (Buddle Findlay)
  • Clerk of the House of Representatives
  • *Institute of Chartered Accountants of New Zealand
  • Integrated Economic Services
  • Legislation Advisory Committee
  • Local Government New Zealand
  • *Mr Tom McRae
  • Mr Rob Munro
  • New Zealand Society of Local Government Managers
  • Office of the Ombudsman
  • *Reserve Bank of New Zealand
  • Mr Ivan Webster

*Denotes those submissions that were heard by the committee.

Wellington, New Zealand:

Published by Order of the House of Representatives -1998

Page last updated: 15 January 2007

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